Buzz

This is the last post in a six-post series on impact by ACS Associate Will Nielsen.

Spoiler Alert: Current efforts to put our financial resources towards initiatives that generate positive impacts may be well intentioned but are often limited in their ability to measure impact and rely on under-developed economic principles. In response, an accounting of impact measurement methodologies could support realignment of financial resources away from unknown impact and towards known impact.

Implications for Business and Investing

The development of impact-oriented ventures, such as impact investing, conservation finance, social enterprises, have arisen, in part, from an inability to completely understand how traditional business impacts society — both in terms of benefits and costs. These mission-oriented initiatives are a response from a desire to understand if and how a business or investment is doing something positive (or not) for society. Often, it is assumed that if it is unknown whether a business is doing society any good, it must be doing harm. This shift towards an increased understanding of impact can become a virtuous cycle as those who both own and spend the money demand and request it be invested in areas without known negative effects. Transparency initiatives will further limit investors ability to escape public scrutiny. As our understanding if impact increases, global markets will be reoriented towards an improved risk, return, and impact profile.

While the desire for impact measurement has increased, the ability and practice of actually measuring it is weak. As Sasha Dichter of the impact investing firm Acumen put it: ‘there is a justifiable concern about both the costs and the benefits of rigorous impact assessment’. Billions of dollars labeled for impact purposes are devoted to companies implementing impact measurement initiatives that are providing minimal relevant information to the investor and stakeholders. Further, there are many more potential externalities, that are not tracked, that could skew the perception of the positive impact from a venture, compared to the often few impact metrics the venture can/will actually track. Thus, impact assessment is not only challenging, it should be viewed with a critical eye.

While access to information continues to be a challenge, impact-oriented ventures cannot afford to completely abandon economic principles either. Businesses focused solely on profit understand economics. And, economists devote much effort to studying the dynamics of such businesses, often creating a feedback whereby the economists determine what is most theoretically efficient for profit-seekers and businesses then pursue that efficiency through activities such as innovation, policy reform, or organizational restructuring. Thus, a current obstacle is that business as usual economics breeds business as usual businesses. If impact enterprises are going to flourish, we will need to shift the field of economics in a way that supports them. One potential avenue to do so is through an improved understanding of the impact and building that into the traditional risk-return paradigm.

To sum up this impact blog series, I hope to have communicated to you the the various facets and complexities of trying to understand impact and shed a small light on the potential paths to take for improving our understanding of impact. A next step is an assessment of the methodologies used to measure impact and how it can help guide financial investments. To do this, a Taxonomy of Impact Measurement Methodologies will be needed that identifies the core concepts of measurement and the assortment of details that define a meaningful measurement. This Taxonomy is what has been keeping me up at night. Stay tuned…

This is the fifth post in a six-post series on impact by ACS Associate Will Nielsen.

Spoiler Alert: Because the world is exceptionally complex, spending large amounts of resources to calculate a specific number for an impact generated may not be feasible or desirable. Instead, understanding change measurements will often be more beneficial for decision-making, such as how a system moves and how variables grow and shrink.

The capacity of the human mind for formulating and solving complex problems is very small compared with the size of the problem whose solution is required for objectively rational behavior in the real world or even for a reasonable approximation to such objective rationality.

— Herbert Simon, 1957

Dynamics and Complexity

Uffda. So as Herbert says, our puny minds can’t handle much. But, the economy - and more generally the world we live in - is highly dynamic, dependent on many nonlinear and interacting factors. A dynamical system consists of a set of variables moving forward in time, influencing and creating the complete environment. In the study of system dynamics, a primary interest is understanding the qualitative features of solutions, not necessarily the specific quantitative values. In other words, we do not necessarily need to seek out precise numerical value; but rather, understand how certain factors behave through time. For example, it is not always necessary to try to assign a specific dollar value for social and environmental impacts that are inherently poorly understood, although this can still be used in cases to support a message. It may, in cases, be more appropriate to understand how quickly the measurement changes and in which direction. Relatedly, it may be more informative to discover what variables contribute most significantly to the changes you are seeking to track. Sounds easy right?

Complexity forces us to analyze problems with a myriad of constantly evolving methods in order to better understand the existence of causality amongst the various parts a complex system. Garrett Hardin described it well:

If we are to correct the consequences of the world’s actions, we must understand the machinery that accounts for these consequences

— Garret Hardin

In order to understand impacts, it is critical to understand the initial states of systems. Any attempt to determine where a system is headed will inherently depend on where it began. An inaccurate depiction of a system’s starting point (it’s initial state) will only further erode the accuracy of any estimate of its trajectory. For example, an economic model that makes predictions based on rational expectations misrepresents the starting point by claiming humans are rational beings. Most researchers agree that humans often make decisions based on little, if any rationality. Thus, any prediction on future trajectories is likely going to be wrong based on a flawed initial understanding of the system.

In addition to the need for understanding a system’s initial conditions, we also need to recognize the scope of the initial conditions and the ability of a system to scale. Different conditions and different initiatives will result in different potentials for scale. Understanding how scaling could occur and the patterns that will be visible from different perspectives improves the understanding of future impact.

In sum, we’ve got a bunch of complexity and dynamics feeding into our systems of interest. We’ve realized multiple systems and factors are interconnected, but they are difficult to understand thanks to the perpetual issue of imperfect information. That about sums it up. Successfully tackle this challenge—and we will know all impacts about everything. I can’t wait to get started. So what to do? One option is to throw some money at it. That’s right, Part 6 is about investing for impact.

This is the fourth post in a six-post series on impact by ACS Associate Will Nielsen.

Spoiler Alert: Systems thinking promotes recognition of the wide ranging linkages and impacts possible from an initial action as well as necessitates greater connection between the sciences and studies of those impacts to maximize knowledge gained.

We frequently talk about side effects as if they were a feature of reality. Not so. In reality, there are no side effects, there are just effects. When we take action, there are various effects. The effects we thought of in advance, or were beneficial, we call the main, or intended effects.

— Richard Sterman, 2000

Systems Thinking

Just because an impact is unintended does not make it any less important.

Building on Richard Buchanan’s ideas in his paper Wicked Problems in Design Thinking, we need to think more about systems. Systems thinking can be used to push the boundaries of the current separation between theory and practice, which ‘remains a source of disruption and confusion in contemporary culture’. Buchanan argues that the discussion needs to move toward ‘the concrete interplay and interconnection of signs, things, actions, and thoughts’.

Here are a few brief examples of activities (or in economics lingo: transactions) that can cause far reaching impacts when we consider the full system:

A new house is built with less expensive lumber imported from a country struggling with illegal logging. This leads to increased corruption in that country and an erosion of the rule of law.

The word choice in a public official’s statement on the local economy creates increased anxiety in 40% of the population. This leads to a population shift away from the city center and increased segregation of income levels.

A butterfly garden has a butterfly that flaps its wings and creates a tornado 350 miles east destroying a handful of farm buildings and hundreds of acres of crops. This is the classic example of the butterfly effect—a small initial event that can lead to much larger events, but now with the incorporation of a market transaction in the form of the cost to visit the butterfly garden, i.e. the source of the tornado.

Few methods exist to understand these scenarios in their entirety. Recognizing where causality exists in each of these examples is a key step in developing new forms of systematic thinking. Linking the initial conditions of new home construction, word choice in a public statement, and a butterfly’s wings to the results of erosion of rule of law, income segregation, and damaged crops are examples of desired outputs of systems thinking.

To do this we need to expand the connections between mathematics, sociology, economics, biology, and physics. The world does not operate within distinct silos; rather, it is a shifting, blended space where all sciences are woven together. Yet, our study of the connections between disciplines cannot be limited to what we already understand. It must expand into the realm of interconnected disciplines—the study of the relationships between various aspects of our lives.

To understand these interconnections better, we will turn to the subjects of dynamics and complexity in Part 5.

This is the third post in a six-post series on impact by ACS Associate Will Nielsen.

Spoiler Alert: The importance of imperfect information becomes even more important within the context of the interconnected nature of all aspects of economies. Different economic philosophies demonstrate the importance of interconnectedness. They also clarify how our current capacity to understand interconnectedness limits the total net benefits that can be generated.

Interconnectedness of Economies

When viewed from a systems perspective, the interconnectedness of the economy, of all economies, becomes readily apparent. The smallest of microeconomic decisions lead to shifts in personal-level and firm-level actions, which lead to industry-level shifts, which lead to regional changes that, upon aggregation, form the macroeconomic trends of entire nations—which are all derived from these small beginnings, sometimes referred to as microfoundations. The speed and ease of moving almost everything (e.g., products, money, people, ideas, and news) only amplifies this interconnectedness as decisions made in one part of the world can quickly flow through a range of economic players around the world. Deep, I know.

In Adam Smith’s idea of the invisible hand and its distribution of unintended social benefits, the importance of the interconnectedness of the economy and the people in it also becomes readily apparent. However, the metaphor of an invisible hand only rings true for people pursuing economic opportunity they can see—they can recognize and take advantage of. For all the opportunities we cannot yet see, there is no invisible hand to distribute social benefits. More so, for many, these unseen opportunities cannot be recognized because the working of the invisible hand depends on our ability to place economic value on all resources used.

Thus, the invisible hand of free markets can serve society only as far as our current understanding of resources and their scarcity exists. An inability to effectively value many resources known to be valuable (e.g, freedom and clean air) is an example of the invisible hand’s limitations. This conundrum was famously described in the tragedy of the commons (sounds like the name of an ancient Greek play, but really it’s a theory that public resources get overused if we all act only in our own self-interest).

An alternative perspective is Alexis de Tocqueville’s idea of self-interest properly regarded and enlightened self-interest. It essentially claims that by serving the interests of others will end up serving your own. While sounding noble and altruistic, it still requires knowing what everybody else’s interests are. Figuring that out is not always so easy.

There are many connections we still do not understand fully and in a market of imperfect information (see Part 2), unforeseen risks will persist and negative externalities will propagate — no matter how efficient the invisible hand is working. The simple, sole pursuit of money could push us down a path of warring kingdoms, where power accumulates to the few and democracy is tested. While many of us enjoy Game of Thrones, it’s not a particularly effective vision for maximizing the well-being of the masses. While an enlightened self-interest shows promise, we need to know more about impacts to know how enlightened our decisions really are.

With all of these economic philosophies, there is an interconnectedness that impacts everyone and everything in the economy. To better understand these complex connections, we need a holistic frame of thinking. Conveniently, systems thinking is the subject of Part 4. Isn’t it nice when things just work out like that.

This is the second post in a six-post series on impact by ACS Associate Will Nielsen.

Spoiler Alert: To improve our understanding of causality and impact, we face a battle with imperfect information that permeates every aspect of our lives. On top of that, getting better information can be expensive. Identifying information thresholds that trigger changes in ideas and behavior can help guide learning about causality.

Imperfect Information

As is well described in the economic literature (which we all love to read), imperfect information is the primary culprit to our lack of understanding (or misunderstanding) of impact. A secondary culprit is the associated costs of acquiring sufficient relevant information, often referred to as transaction costs.

Externalities and market failures are not what is the matter with the world, nor is it externalities and market failure that prevent us from reestablishing the Garden of Eden here on earth — our sad state of affairs is rather due to positive transaction costs and imperfect information.

— Carl Dahlman, 1979

The issue of imperfect information is multi-faceted. We are faced with a perpetual struggle against misinformation, incomplete information, out-of-context information, and the obfuscation of information. This struggle defines our everyday life (If you’re not struggling with this, congrats, you’ve attained enlightenment, please help the rest of us. Alternatively, congrats—ignorance is bliss). Thus, we must focus more effort on information, working to translate the messages we receive into a practical description of our condition.

To achieve the desired level of understanding we would need perfect information. But, of course, the reality of perfect information’s existence is only in the form of a thought experiment: an imaginary, fantastical, unrealized state of affairs. This, however, does not mean a more complete understanding of the status quo should not be pursued. We must develop ways to improve our information, make it more perfect, more encompassing, more cross-cutting, more widely understandable, more readily actionable, and more broadly accepted.

Let’s dive into an example. Due to imperfect and asymmetric information (i.e., different parties have different amounts of information), traditional markets tend towards markets of lemons. Lemon being the term used to describe a poor-quality product, originally that used car we are all terrified of buying. The market of lemons as described by George Akerlof, Nobel Prize winner in Economics, is a market that occurs when consumers cannot distinguish a quality product from a lemon and only one price exists in the market (e.g., good and lemon cars cost the same). Thus, the price will be driven down and high-quality products will eventually leave the market, leaving nothing but lemons. To expand this concept more generally, lemons are not just products and services, but also can represent a company, government program, or an entire sector.

In the case of a company, the problem is we often cannot distinguish the lemon companies from the quality companies due to the imperfect information on (and understanding of) how a company’s impacts affect us. Efforts in Corporate Social Responsibility (CSR) reporting and a variety of certification efforts (such as B Corp) are designed to help overcome this. But, many CSR reports and certification programs are optional and are often used as marketing tools to highlight how amazing and considerate companies are.

Still, simply knowing about the existence of an externality, no matter the size of its impact, can be enough to help resolve externalities—in some cases. For example, knowing solely whether an impact is positive or negative. Overcoming some threshold of imperfect information, which will vary from party to party, can allow affected parties to change their behavior or the behavior of others.

As information improves, the connections within society and economies become more apparent, and this is our subject for Part 3.

This is the first post in a six-post series on impact by ACS Associate Will Nielsen.

Spoiler Alert: The impacts of much of our actions are unknown. New approaches will be needed to recognize and improve our understanding of causality and the full scope of impacts.

Throw a stone into the stream and the ripples that propagate themselves are the beautiful type of all influence.

— Ralph Waldo Emerson, 1836

We Know So Little

As Ralph nicely said, every action we take creates ripples, ripples that flow outwards, impacting and changing all aspects of their environment in some way.

But we know very little about the full impacts of our actions—our actions as individuals, as businesses, or as a society. The economic, financial, social, environmental, emotional, and psychological impacts (for starters) are all only partially understood, if at all. We are continually improving our understanding through research and experiences, but the pace must change.

If we want to make well-informed decisions—across policy, business, investments, and health—we will need methods of analyses that draw on and combine all of the aforementioned forms of impact in order to create a more complete image of change. This includes taking into account the interconnected flows of externalities and the side effects accrued (maybe unwillingly) by third parties, both positive and negative. This is important because the recognition of one positive effect does not mean there are not many negative effects we do not currently see.

Above all, for a full conception of impact, we’ll need to strengthen our grasp on causality: finding the cause(s) for each effect. However outlandish that goal may be. Recognizing causality and impact will allow for increased recognition of potential future risks, boosting our well-being and of those around us.

And so, where should we start to tackle this possibly hopeless, how-can-we-ever-hope-to-understand-everything, mission? The beginning is as good a place as any, and it starts here.

Acknowledgement: Many thanks to Tarek Haffar, Josh Donlan and Drew Tulchin for their very constructive feedback on this blog series.